Author Topic: Borrow to invest?  (Read 5178 times)

jul059

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Borrow to invest?
« on: September 03, 2013, 04:38:59 PM »
I am wondering if borrowing to invest might sometimes be a sound idea. Here's my situation. I will soon be finishing school with a surplus of money that my government has lent me during my studies. I do not pay any interests while I'm still in school, but will be paying 3.5% as soon as I'm done. Now, 3.5% is not a very high interest rate for a loan and I'm thinking it might be profitable to invest the money instead of clearing the debt.

I guess it all comes down to the risk I'm willing to take. What if my investment doesn't do any better than 3.5%? Would there be other ways to use this money with similar risk?

What's you opinion on this?

btw I'm in Canada.

EDIT : Some more info : I will have a masters degree in mechanical engineering. Current income (student) 17k, tax free. Estimated income immediately after school : 35 after tax.
« Last Edit: September 04, 2013, 12:18:02 PM by jul059 »

Numbers Man

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Re: Borrow to invest?
« Reply #1 on: September 03, 2013, 04:40:58 PM »
Not a good idea for someone that doesn't have a safety net to cover any losses that may occur.

mgreczyn

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Re: Borrow to invest?
« Reply #2 on: September 03, 2013, 04:45:14 PM »
Your choice, but there's no way I would.  The problem is one of timing.  Over the long run, the market will certainly return more than 3.5%.  However, there are definitely years and multiple year sets where market returns are lower then 3.5%, sometimes way, way lower.  You only know which years they are in hindsight, which is why you can look at a chart of stock market returns and rationalize borrowing at 3.5% to invest in the stock market. 

livetogive

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Re: Borrow to invest?
« Reply #3 on: September 03, 2013, 04:50:45 PM »
Welcome to the wonderful world of leverage.  People do the same thing all the time when they take out a mortgage to buy a home, except instead of putting the money into a home you're probably contemplating the stock market or similar.

I work in financial services and I personally wouldn't do it, but I can see the appeal.  I think you should ask yourself a few things first:

1.)  Do I get a tax benefit from the student loan interest?
2.)  How much money could I invest? 
3.)  Can I make the payments & keep a roof over my head if I lose everything in a downturn?
4.)  Am I planning on buying a home anytime soon*?
5.)  Do I have ANY other debt?  (car payment, credit card, etc.)
6.)  Am I breaking any laws by holding onto the unused cash?  What's the penalty and likelyhood of getting caught?

*you could theoretically use this money as a down payment.  I know one big factor of mortgage lending in the US is your capacity to service debt, which is currently reduced by your student loan payment.  If buying now makes sense, I'd hold the cash to make up for the lost capacity and use it towards a home assuming you won't get a mortgage for less than 3.5%.

With the exception of the house, every time I've looked at the same question I've come up with it's better to just pay off the debt.  Say you make 7% on your investments after taxes, which is pretty good.  You're only clearing 3.5% of the principal balance annually, but you have the stress of personal leverage and the threat of another 2008. YMMV.  I know others on this board are much more aggressive than I am.

gooki

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Re: Borrow to invest?
« Reply #4 on: September 04, 2013, 01:37:02 AM »
The only way I'd recommend it is if you have your lifestyle 100% under control. It is very easy to slip into the mindset of spending $100 here or there instead of investing it. At which point an aggressive debt repayment plan may well serve you better.

marty998

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Re: Borrow to invest?
« Reply #5 on: September 04, 2013, 01:45:19 AM »
The market's a bitch at the best of times, but when leveraged she will take you for everything you have and more.

There is one Aussie floating around here who has done very well out of it (Bigchrisb) but imho he is the exception rather than the rule.

ioseftavi

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Re: Borrow to invest?
« Reply #6 on: September 04, 2013, 09:00:44 AM »
The market's a bitch at the best of times, but when leveraged she will take you for everything you have and more.

Solid advice there.  If you've been investing in the market for years without leverage, then perhaps you can try it.  I wouldn't personally, or at least not at present.

If this is your first time out in 'the real world' working full time, focus on the fundamentals of budgeting, saving, investing without leverage, etc.  Pay down your loan with the excess cash you have. 


Spork

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Re: Borrow to invest?
« Reply #7 on: September 04, 2013, 09:10:07 AM »

Short answer: no.

Longer answer: If you have large stainless steel testicles, feel free to try.  I would never go further than what I could cover though.  In other words: I would keep actual, real, relatively stable investments with a value of 2-3x (maybe more) the amount of the investments I had on margin.  Remember that if the market shrinks, they can make a margin call and require you to pay up.

JohnGalt

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Re: Borrow to invest?
« Reply #8 on: September 04, 2013, 09:35:45 AM »
I'm surprised by all of the "no don't do it" answers here..

This is the equivalent of choosing to invest before paying off your student loan early (or your mortgage for that matter).  At 3.5% interest, and no possibility of a margin call or really much other risk besides that you might get a worse return on the invested money than the 3.5% you're paying to borrow it - it's actually a no brainer to me.
« Last Edit: September 04, 2013, 09:44:46 AM by JohnGalt »

matchewed

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Re: Borrow to invest?
« Reply #9 on: September 04, 2013, 09:41:24 AM »
I have to agree with JohnGalt here. Although I'm not a huge fan of borrowing to invest, if you have a surplus that isn't needed for other items it is completely legitimate to invest that surplus. 3.5% is quite low given historical Canadian market performance. Canada generally has equivalent returns to the US with less volatility associated with it.

Kazimieras

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Re: Borrow to invest?
« Reply #10 on: September 04, 2013, 09:47:50 AM »
I would not do it, but that's me. In order to make a decent return on the money you need to earn 3.5% guaranteed, and that just doesn't happen without taking on some risk. If I were you, toss the money in your TFSA if you haven't already. Once you start working you will be claiming any unused tuition credits against your income. Once those run out, start to dump the money from the TFSA into your RRSP, generating a tax refund and lowering your tax bracket (assuming you're earning a decent wage). Then again, it depends what your next life goals are, that money could be a good downpayment on a house (if you want to go that route).

livetogive

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Re: Borrow to invest?
« Reply #11 on: September 04, 2013, 09:59:50 AM »
This type of leverage is pretty common - I don't think that's the issue.  I agree that it may be more tax efficient to do something else but this could be cheap money for a down payment and avoid PMI.

bogart

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Re: Borrow to invest?
« Reply #12 on: September 04, 2013, 10:44:57 AM »
I've opted to prioritize contributing to my tax-sheltered retirement accounts (403b, Roth IRA) rather than paying down my mortgage early, which is not exactly the same, but very close to, what you are asking about.  I'm surprised at the reluctance others are expressing.  In your shoes I think I'd (a) make the minimum required payments on my student loans; (b) focus initially on building up a modest but adequate emergency fund (what constitutes adequate is a function of variables I don't know for your case, things like extant commitments/responsibilities and job security); (c) invest; (d) don't do (c) with the expectation that those funds will be available to you anytime soon. 

mpbaker22

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Re: Borrow to invest?
« Reply #13 on: September 04, 2013, 11:14:43 AM »
Why is everyone saying no?  I don't see how this is different than having a home loan at 3.5% and investing other money.  As long as you have a job where you can pay the monthly payments, it's a pretty low-risk proposition.

mgreczyn

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Re: Borrow to invest?
« Reply #14 on: September 04, 2013, 11:18:54 AM »
Primary reason for me is that OP mentioned absolutely nothing about actually having said job.  This is a student loan, taken out while OP is still a student and (presumably) unemployed.  So in my view, having no income and borrowing more than you need on a long term note in order to invest in something that has substantial short term risk is ill advised. 

I'm surprised so many people on the MMM forum would advocate taking a loan out with no stated income.  Have we been invaded by a bunch of 2006-vintage mortgage loan officers?
« Last Edit: September 04, 2013, 11:28:03 AM by mgreczyn »

jul059

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Re: Borrow to invest?
« Reply #15 on: September 04, 2013, 12:18:45 PM »
Thanks for all the input. I added some income info, see first post.

mpbaker22

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Re: Borrow to invest?
« Reply #16 on: September 04, 2013, 12:28:47 PM »
Where are you studying ME that your expected income is only 35K?  I suppose that is after taxes, but it still seems low to me, but i'm not an engineer.

I guess it probably does make sense to not invest it since there is a risk of losing money and defaulting on the loan.  But once you have a job, or if your current job covers the payments, you should be ok investing it. 

Assuming you have a job that makes payments, it's not any different than taking a loan on a house instead of paying cash, if you have the cash laying around.

JohnGalt

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Re: Borrow to invest?
« Reply #17 on: September 04, 2013, 01:27:28 PM »
Maybe I'm just less risk averse than most... but I would still keep the money rather than pay it back immediately.  Maybe that could just be to fund your emergency fund until you actually land that first job rather before investing in something more risky such as the stock market.  3.5% interest is just to juicy for me to pass up - I would borrow and borrow and borrow (and invest) until they cut me off at that rate. 

Spork

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Re: Borrow to invest?
« Reply #18 on: September 04, 2013, 02:13:02 PM »
I'm surprised by all of the "no don't do it" answers here..

This is the equivalent of choosing to invest before paying off your student loan early (or your mortgage for that matter).  At 3.5% interest, and no possibility of a margin call or really much other risk besides that you might get a worse return on the invested money than the 3.5% you're paying to borrow it - it's actually a no brainer to me.

I may have misread it...  I was actually reading the original post as "should I borrow more to invest" ... i.e, invest on margin fresh out of school in addition to having a student loan.

Re-reading... it probably looks like it was "should I pay minimum amounts and invest the surplus".

Given the first interpretation: I stick with 'no'.
Given the second... doesn't seem so harmful, given enough income to cover costs, etc.

tomsang

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Re: Borrow to invest?
« Reply #19 on: September 04, 2013, 02:24:44 PM »
At your age and with a 3.5% locked in loan, I would borrow as much as you can get and handle the monthly payment.  You will turbo charge your FI while taking on minimal risk.  If the market is down for 10 plus years(or whatever the term of the loan is), that means you will need to work an extra year.  If the market delivers anything close to market averages, you will take off a year or two. 

Having money liquid in the form of investments provides you with the opportunity to capitalize on amazing deals.

If you have a tendency to blow money then paydown the debt.  If you are not comfortable investing and the money would sit in a savings account earning .5% then paydown the debt.  If you have good discipline you will be rewarded by the government's free money.

Have fun!

willn

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Re: Borrow to invest?
« Reply #20 on: September 04, 2013, 03:37:32 PM »
No way would I do this.

You don't need to do this to become FI and it increases your risk.  You make < 20K a year and you "might" make 35K when (if) you get a job.  I say focus on not adding to your debt and getting through school.  Your best investment now is in good grades and good living and getting out of school without debt so that you're future income can be invested, not paying back loans.  You have plenty of time.  Being debt-free when you graduate means you don't have to take the first crap job that's offered because you have to make payments, as one example of many reasons to be debt free.

Your best wealth building tool is your income.  Investing modest amounts over decades will give you plenty of millions without debt.  When you have debt you hobble your future income which then can't be invested.

Let's say you make 10%. But you're paying 3.5% interest so that's only 6.5%.  And you pay taxes of say 25% of the 10%--the interest expense won't be tax deductible.  My opinion is you're increasing risk way too much for a merely possible 5% return.
« Last Edit: September 05, 2013, 06:10:45 AM by willn »

AJDZee

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Re: Borrow to invest?
« Reply #21 on: September 04, 2013, 09:57:36 PM »
It is exciting to try to optimize every avenue you can when you have a clear FI goal in mind, but this is not worth it. In fact, it's also not allowed. You might want to *triple* check, but if it is a government student loan it has to be used for school-related and living costs. That's what I know of it at least. It's hard for the government to prove that's directly what you used the money for, but I don't think it's worth the risk.

For those that say roll it into TFSA and RSP, it's not a scholarship, this money will need to be paid back. For those that say 'use it as an emergency fund after you graduate' - no, it's not an emergency fund if you're paying interest on it. In fact you'd be better off having a line of credit as a pseudo Emerg Fund because at least you'd only pay interest on money you used rather than 3.5% on everything.

In the grand scheme of things it simply won't be worth it, we're only talking about a few grand here, in fact it's more like a few percent of a few grand (10 - 3.5%), for a few years. I say you already hold the most valuable asset - time - and you clearly know the magic of compounding, so you'll be fine.